allen's theory of value

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Allen’s Theory of Valueincluding

A Brief and Selective History of the Stock Marketand

Various Observations, Notes and Excursions

Columbus Chapters National Investor Relations Institute & Financial Executives InstituteColumbus, OhioOctober 13, 2009

Brad Allen

Editor & PublisherRiskRewardNews ©

brad@bdallen.com612.386.3415

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The Earnings Release ProcessOnce upon a time…

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Today, stocks trade instantaneously on news.

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Agenda• Where does value come from?• What’s been happening in the market?• Business case for business ethics

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Price

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Price ≠ Value

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Value

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Price = Value

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Risks• Exogenous/Market Risks

• Endogenous/Firm Risk-- Interest rates, currency, economic, systemic…

-- MarketsCompetition, regulation, growth vs. maturity …

-- ProductsDifferentiation, IP, replacement, capital, cost, obsolescence…

-- ManagementCompetence -- consistency, predictability, experience, strategic thinking, decisivenessCredibility -- governance, compensation, commitment, transparency, honesty, integrity

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Agenda• Where does value come from?• What’s been happening in the market?• Business case for business ethics

Brief History of Wall St.

• 1949 – Alfred W. Jones creates the first Hedge Fund• 1952 – 6.5 million Americans own stock• 1954 – DJIA surpasses 1929 pre-crash peak• 1961 – Average daily volume on the NYSE exceeds 4 million shares• 1971 – NASDAQ established as first electronic stock exchange in the world trading ~ 2500 stocks• 1972 – SIAC (Securities Industry Automation Corp.) established• 1974 – ERISA (Employee Retirement Income Security Act)• 1975 – “Big Bang” fixed commissions abolished• 1976 – DOT (Designated Order Turnaround), electronically routing small orders; -- Program Trading begins• 1978 – 401K Plans established• 1979 – ITS (Intermarket Trading System) established• 1982 – One day NYSE volume exceeds 100 million shares• 1991 – NYSE establishes after-hours trading session• 1992 – Average daily NYSE volume exceeds 200 million shares• 1994 – NASDAQ passes NYSE in total shares traded• 1996 – ~47 million Americans own stock• 1997 – NYSE one day volume tops 1 billion shares• 1998 – NASDAQ and AMEX combine• 2000 – Decimalization: trading in $0.01 increments begins• 2005 – Reg NMS (National Market System) established• 2006 – NYSE goes public (ticker NYX); 60% of trades on London SE algo (algorithmic) trading• 2009 – Number of hedge funds equals or exceeds listed companies (est. between 4,000 and 8,000) • 2009 – HFT (High Frequency Trading) ~ 73% of all US trading volume; Assets under HFT management ~$14 bn, down 21%

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Liquidity↑

Friction ↓

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NYSE Avg. Holding Periods1920 - 2009

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Brief History of Wall St. (cont.)

Modern Finance: Pricing & Behavior can be Modeled

• 1961 – CAPM (Capital Asset Pricing Model)• 1973 – Black-Scholes Option Pricing Model• 1976 – Theory of the Firm (Agency Theory)

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Brief History of Wall St. (cont.)

• 1987 – Largest One-Day Percentage Drop in NYSE History – Portfolio Insurance Gone Wild

• 1998 – Long Term Capital Management fails– Even Nobel Laureates make mistakes

• 2008 – Market Meltdown – Worst financial crisis since 1929 – PhD dissertation topics for years to come

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Models are Models, the World is the World or

The Map is Not the Terrain

“We make models to abstract reality. But there is a meta-model behind the model that assures us the model will eventually fail. Models fail because they fail to incorporate the inter-relationships that exist in the real world.”Myron Scholes; New York, Sept. 2005

“We had events that our models showed would happen once in every 10,000 days. We had three of them in that week. Either three Black Swans came in simultaneously OR the models are wrong.”Bill George, Goldman Sachs board member, 2009

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Risks• Exogenous/Market Risks– Interest rates, currency, economic, systemic…

• Endogenous/Firm Risk– Markets

• Competition, regulation, growth vs. maturity …

– Products• Differentiation, IP, replacement, capital, cost, obsolescence…

– Management• Competence -- consistency, predictability, experience,

strategic thinking, decisiveness• Credibility -- governance, compensation, commitment,

transparency, honesty, integrity

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Agenda• Where does value come from?• What’s been happening in the market?• Business case for business ethics

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Albanian Lek Crisis

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Brief History of Wall St. (cont.)

• 1986+ – Milliken, Boesky, Levine, Siegel…– “I’ve got a secret.”

• 2001+ – Enron, Tyco, WorldCom, Adelphia…– “Catch me if you can.”

• 2004+ – Blodgett, Grubman…– “A sucker is born every minute.”

• 2008+ – AIG, CitiGroup, Lehman, BoA…– “It’s my ball, and I’ll play the way I want to.”

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Risks• Exogenous/Market Risks– Interest rates, currency, economic, systemic…

• Endogenous/Firm Risk– Markets

• Competition, regulation, growth vs. maturity …

– Products• Differentiation, IP, replacement, capital, cost, obsolescence…

– Management• Competence -- consistency, predictability, experience,

strategic thinking, decisiveness• Credibility -- governance, compensation, commitment,

transparency, honesty, integrity

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In Conclusion…

• Markets Matter• IR Matters• Integrity Matters• You Matter

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Thank You!